(2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Principles of Consolidation

The accompanying consolidated financial statements include the accounts of the Company’s wholly owned subsidiaries, Exact Sciences Laboratories, LLC, Exact Sciences Finance Corporation, Exact Sciences Europe LTD, Beijing Exact Sciences Medical Technology Company Limited, and variable interest entities. All significant intercompany transactions and balances have been eliminated in consolidation.

References to “Exact”, “we”, “us”, “our”, or the “Company” refer to Exact Sciences Corporation and its wholly owned subsidiaries.

Use of Estimates

The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

Cash and Cash Equivalents

The Company considers cash on hand, demand deposits in bank, money market funds, and all highly liquid investments with an original maturity of 90 days or less to be cash and cash equivalents. no

Marketable Securities

Management determines the appropriate classification of debt securities at the time of purchase and re-evaluates such designation as of each balance sheet date. Debt securities carried at amortized cost are classified as held-to-maturity when the Company has the positive intent and ability to hold the securities to maturity. Marketable equity securities and debt securities not classified as held-to-maturity are classified as available-for-sale. Available-for-sale securities are carried at fair value, with the unrealized gains and losses, net of tax, reported in other comprehensive loss. The amortized cost of debt securities in this category is adjusted for amortization of premiums and accretion of discounts to maturity computed under the straight-line method. Such amortization is included in investment income. Realized gains and losses and declines in value judged to be other-than-temporary on available-for-sale securities are included in investment income. The cost of securities sold is based on the specific identification method. Interest and dividends on securities classified as available-for-sale are included in investment income.

At March 31, 2016 and December 31, 2015, the Company’s investments were comprised of fixed income investments, and all were deemed available-for-sale. The objectives of the Company’s investment strategy are to provide liquidity and safety of principal while striving to achieve the highest rate of return consistent with these two objectives. The Company’s investment policy limits investments to certain types of instruments issued by institutions with investment grade credit ratings and places restrictions on maturities and concentration by type and issuer. Investments in which the Company has the ability and intent, if necessary, to liquidate in order to support its current operations (including those with a contractual term greater than one year from the date of purchase) are classified as current. All of the Company’s investments are considered current. There were no realized losses for the three months ended March 31, 2016 and 2015. Realized gains were $3.3 thousand and $3.0 thousand for the three months ended March 31, 2016 and 2015, respectively.

We periodically review our investments in unrealized loss positions for other-than-temporary impairments. This evaluation includes, but is not limited to, significant quantitative and qualitative assessments and estimates regarding credit ratings, collateralized support, the length of time and significance of a security’s loss position, our intent not to sell the security, and whether it is more likely than not that we will have to sell the security before recovery of its cost basis. For the three months ended March 31, 2016, no investments were identified with other-than-temporary declines in value.

Available-for-sale securities at March 31, 2016 consisted of the following:


	March 31, 2016
			Gains in Accumulated		Losses in Accumulated
			Other Comprehensive		Other Comprehensive		Estimated Fair
(In thousands)	Amortized Cost		Income		Income		Value
Corporate bonds	$	132,854	$	93	$	(41)	$	132,906
Asset backed securities		62,380		12		(44)		62,348
U.S. government agency securities		7,057		8		—		7,065
Certificates of deposit		5,500		2		—		5,502
Commercial paper		2,621		—		(1)		2,620
Total available-for-sale securities	$	210,412	$	115	$	(86)	$	210,441

Available-for-sale securities at December 31, 2015 consisted of the following:


	December 31, 2015
			Gains in Accumulated		Losses in Accumulated
			Other Comprehensive		Other Comprehensive		Estimated Fair
(In thousands)	Amortized Cost		Income		Income		Value
Corporate bonds	$	179,471	$	2	$	(262)	$	179,211
Asset backed securities		77,661		—		(166)		77,495
U.S. government agency securities		7,057		—		(18)		7,039
Certificates of deposit		1,999		—		—		1,999
Total available-for-sale securities	$	266,188	$	2	$	(446)	$	265,744

Changes in Accumulated Other Comprehensive Income (Loss)

The amounts recognized in accumulated other comprehensive income (loss) (“AOCI”) for the three months ended March 31, 2016 were as follows (in thousands):


					Accumulated
	Cumulative		Unrealized		Other
	Translation		Gain (Loss)		Comprehensive
	Adjustment		on Securities		Income (Loss)
Balance at December 31, 2015	$	11	$	(444)	$	(433)
Other comprehensive (loss) income before reclassifications		(57)		456		399
Amounts reclassified from accumulated other comprehensive loss		—		17		17
Net current period change in accumulated other comprehensive income (loss)		(57)		473		416
Balance at March 31, 2016	$	(46)	$	29	$	(17)

The amounts recognized in AOCI for the three months ended March 31, 2015 were as follows (in thousands):


					Accumulated
	Cumulative		Unrealized		Other
	Translation		Gain (Loss)		Comprehensive
	Adjustment		on Securities		Income (Loss)
Balance at December 31, 2014	$	—	$	(115)	$	(115)
Other comprehensive (loss) income before reclassifications		(10)		192		182
Amounts reclassified from accumulated other comprehensive loss		—		3		3
Net current period change in accumulated other comprehensive income (loss)		(10)		195		185
Balance at March 31, 2015	$	(10)	$	80	$	70

Amounts reclassified from AOCI for the three months ended March 31, 2016 and 2015 were as follows (in thousands):


	Affected Line Item in the	Three Months Ended March 31,
Details about AOCI Components	Statement of Operations	2016		2015
Change in value of available-for-sale investments
Sales and maturities of available-for-sale investments	Investment income	$	17	$	3
Total reclassifications		$	17	$	3

Property and Equipment

Property and equipment are stated at cost and depreciated using the straight-line method over the assets’ estimated useful lives. Maintenance and repairs are expensed when incurred; additions and improvements are capitalized. The estimated useful lives of fixed assets are as follows:


		Estimated
Asset Classification		Useful Life
Laboratory equipment		3 - 5 years
Computer equipment and computer software		3 years
Leasehold improvements		Lesser of the remaining lease term or useful life
Furniture and fixtures		3 years
Buildings		30 years

At March 31, 2016, the Company had $4.7 million of assets under construction which consisted of $1.8 million related to leasehold improvements, $1.5 million related to software projects and $1.4 million related to machinery and equipment. Depreciation will begin on these assets once they are placed into service. The Company expects to incur an additional $1.2 million to complete the leasehold improvements, $0.2 million to complete the machinery and equipment, and minimal costs to complete the software projects. These projects are expected to be completed in 2016. There were no impairment losses for the periods ended March 31, 2016 and December 31, 2015.

Software Capitalization Policy

Software development costs related to internal use software are incurred in three stages of development: the preliminary project stage, the application development stage, and the post-implementation stage. Costs incurred during the preliminary project and post-implementation stages are expensed as incurred. Costs incurred during the application development stage that meet the criteria for capitalization are capitalized and amortized, when the software is ready for its intended use, using the straight-line basis over the estimated useful life of the software.

Patent Costs and Intangible Assets

Patent costs, which have historically consisted of related legal fees, are capitalized as incurred, only if the Company determines that there is some probably future economic benefit derived from the transaction. The capitalized patents are amortized beginning when patents are approved over an estimated useful life. Capitalized patent costs are expensed upon disapproval, upon a decision by the Company to no longer pursue the patent or when the related intellectual property is either sold or deemed to be no longer of value to the Company. The Company determined that all patent costs incurred during the three months ended March 31, 2016 should be expensed and not capitalized as the future economic benefit derived from the transactions cannot be determined.

Under a technology license and royalty agreement entered into with MDx Health, the Company is required to pay MDx Health milestone-based royalties on sales of products or services covered by the licensed intellectual property. Once the achievement of a milestone has occurred or is considered probable, an intangible asset and corresponding liability is reported in other long-term assets and accrued expenses, respectively. The intangible asset is amortized over the estimated ten-year useful life of the licensed intellectual property, and such amortization is reported in cost of sales. As of March 31, 2016, an intangible asset of $1.7 million and a liability of $2.0 million are reported in other long-term assets and accrued expenses, respectively. As of December 31, 2015, an intangible asset of $1.8 million and a liability of $2.0 million were reported in other long-term assets and accrued expenses, respectively. Amortization expense for the three months ended March 31, 2016 was $50.0 thousand. There was no amortization expense recorded for the three months ended March 31, 2015.

Net Loss Per Share

Basic net loss per common share was determined by dividing net loss applicable to common stockholders by the weighted average common shares outstanding during the period. Basic and diluted net loss per share are the same because all outstanding common stock equivalents have been excluded, as they are anti-dilutive due to the Company’s losses.

The following potentially issuable common shares were not included in the computation of diluted net loss per share because they would have an anti-dilutive effect due to net losses for each period (amounts are in thousands):


	March 31,
	2016	2015
Shares issuable upon exercise of stock options	5,475	5,222
Shares issuable upon the release of restricted stock awards	6,202	2,305
Shares issuable upon the vesting of restricted stock awards related to licensing agreement	—	24
	11,677	7,551

Revenue Recognition

Laboratory Service Revenue. The Company’s revenues are generated by performing diagnostic services using its Cologuard test, and the service is completed upon delivery of a test result to an ordering physician. The Company recognizes revenue in accordance with the provisions of ASC 954-605, Health Care Entities – Revenue Recognition. The Company recognizes revenue related to billings for Medicare and other payors on an accrual basis, net of contractual and other adjustments, when amounts that will ultimately be realized can be estimated. Contractual and other adjustments represent the difference between the list price (the billing rate) and the estimated reimbursement rate for each payor. Upon ultimate collection, the amount received from Medicare and other payors where reimbursement was estimated is compared to previous collection estimates and, if necessary, the contractual allowance is adjusted.

The estimates of amounts that will ultimately be realized require significant judgment by management. Some patients have out-of-pocket costs for amounts not covered by their insurance carrier, and the Company may bill the patient directly for these amounts in the form of co-payments and co-insurance in accordance with their insurance carrier and health plans. Some payors may not cover Cologuard as ordered by the prescribing physician under their reimbursement policies. The Company pursues reimbursement from such patients on a case-by-case basis. In the absence of contracted reimbursement coverage or the ability to estimate the amount that will ultimately be realized for the Company’s services, revenue is recognized upon cash receipt.

The Company uses judgment in determining if it is able to make an estimate of what will ultimately be realized. The Company also uses judgment in estimating the amounts it expects to collect by payor. The Company’s judgments will continue to evolve in the future as it continues to gain payment experience with payors and patients.

The Company recognized approximately $14.8 million and $4.3 million in laboratory service revenue for the three months ended March 31, 2016 and 2015, respectively.

Inventory

Inventory is stated at the lower of cost or market value (net realizable value). The Company determines the cost of inventory using the first-in, first out method (“FIFO”). The Company estimates the recoverability of inventory by reference to internal estimates of future demands and product life cycles, including expiration. The Company periodically analyzes its inventory levels to identify inventory that may expire prior to expected sale or has a cost basis in excess of its estimated net realizable value, and records a charge to cost of sales for such inventory, as appropriate. In addition, the Company's products are subject to strict quality control and monitoring which the Company performs throughout the manufacturing process. If certain batches or units of product no longer meet quality specifications or become obsolete due to expiration, the Company records a charge to cost of sales to write down such unmarketable inventory to its estimated net realizable value.

Direct and indirect manufacturing costs incurred during process validation and for other research and development activities, which are not permitted to be sold, have been expensed to research and development.

Inventory consists of the following (amount in thousands):


	March 31,		March 31,
	2016		2015
Raw materials	$	2,066	$	2,305
Semi-finished and finished goods		6,091		3,118
Total inventory	$	8,157	$	5,423

Foreign Currency Translation

For the Company’s international subsidiaries, the local currency is the functional currency. Assets and liabilities of these subsidiaries are translated into United States dollars at the period-end exchange rate or historical rates as appropriate. Consolidated statements of operations amounts are translated at average exchange rates for the period. The cumulative translation adjustments resulting from changes in exchange rates are included in the condensed consolidated balance sheet as a component of accumulated other comprehensive income in total Exact Sciences Corporation’s stockholders’ equity. Transaction gains and losses are included in the condensed consolidated statement of operations in 2016.

Reclassifications

Certain prior period amounts have been reclassified to conform to the current period presentation in the condensed consolidated financial statements and accompanying notes to the condensed consolidated financial statements.